Why an Emerging Market Rout Has Hit Indonesia So Hard

As investors flee emerging markets, Indonesia is taking a bigger knock than its peers in Asia. The rupiah has slumped to a 28-month low against the dollar and international investors have dumped $2.2 billion of stocks and bonds since the start of April. The central bank is selling billions of dollars from its reserves to halt the rout and may be forced to raise interest rates for the first time since 2014.

1. What triggered the selloff?

The Federal Reserve has been raising interest rates gradually since late 2015, but as evidence of a stronger U.S. economy and job market mounts, financial markets are starting to price in a faster pick-up in inflation and borrowing costs. U.S. 10-year Treasury yields breached the 3 percent mark for the first time in four years last month, reducing investors’ appetite for assets in so-called emerging markets such as Indonesia. Part of their appeal is their relatively higher yields compared with developed markets. When that differential falls, emerging markets become less attractive.

2. Why is Indonesia being targeted?

It’s one of a few Asian emerging markets that run current-account deficits (so do India and the Philippines). These economies rely on foreign inflows to finance their import needs. Foreign investors own almost 40 percent of Indonesia’s government bonds, among the highest of Asian emerging markets. That makes the economy especially vulnerable to a slump in sentiment and sharp outflows. Add to that the government runs a budget deficit, meaning it needs to borrow to finance spending. Rising debt costs curb its ability to fund development projects, curtailing growth. Already the economy is somewhat lackluster, growing about 5 percent in the first quarter, well shy of the 7 percent that President Joko Widodo targeted when he came to office in 2014.

3. How badly are the currency and stocks faring?

The rupiah just broke through what for traders is a psychologically important level of 14,000 per dollar for the first time since December 2015. The Jakarta Stock Exchange Composite Index, or JCI, is down about 7 percent this year through May 9, compared with a less than 2 percent drop in the MSCI Emerging Markets Index. The JCI has slumped about 12 percent from its Feb. 19 high. That was, however, a record closing price.

#lazy-img-327587512:before{padding-top:56.25%;}4. What has the central bank done to stem the rout?

Bank Indonesia has intervened in both the currency and the bond market to curb losses, draining what was a record stockpile of foreign reserves in January by about $7 billion to $125 billion in April. Officials have called for calm and talked up the economy’s growth propsects as well as reminding investors about the existence of currency buffers, including at least $60 billion in bilateral swap facilities — agreements with Japan, South Korea and others — that provide a second line of defense for the rupiah. Governor Agus Martowardojo also raised the prospect of an interest-rate increase to stem the outflow and bolster the currency.

5. Will it succeed?

The central bank says the market turmoil is short term and that calm will soon be restored. But with the Fed set to continue raising interest rates and the spread between U.S. and emerging market yields narrowing, expect more currency weakness. Some investors, like Schroders Plc, see value in Indonesian assets. Goldman Sachs Group Inc. is betting the central bank will bring forward rate hikes to restore confidence if the volatility continues.

6. Hasn’t this happened before?

In the so-called “taper tantrum” of 2013, when the Fed first raised the idea of withdrawing stimulus, the rupiah was one of the hardest-hit currencies in Asia, dropping more than 20 percent against the dollar that year. Back then, Martowardojo was just a month into his job as central bank governor and surprised markets with an interest rate hike. Finance Minister Sri Mulyani Indrawati has been at pains to point out the economy is in a stronger position than it was in 2013. Indeed, Moody’s Investors Service upgraded Indonesia in April citing steps taken to improve the economy’s resilience to global shocks.

The Reference ShelfRupiah selloff reflects dollar strength not loss of confidence, writes Bloomberg Opinion’s Shuli Ren.Indonesia caught in EM selloff crosshairs.A QuickTake on Indonesia’s protectionism.

— With assistance by Tomoko Yamazaki

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